Natural Alternatives International, Inc. — Form 10-Q Summary
Reporting period: Three months ended September 30, 2012 (fiscal 2013 first quarter); compared with the three months ended September 30, 2011. Financial statement amounts below are in millions of dollars unless noted.
Business context
NAI primarily manufactures nutritional supplements under private-label contracts. It also earns royalty and licensing income related to its CarnoSyn beta-alanine patent estate and sells branded products, principally Pathway to Healing. The company says its sales historically depend heavily on one or two contract-manufacturing customers and on the timing of their orders.
Financial performance and liquidity
| Metric | Q1 FY2013 | Q1 FY2012 |
|---|---|---|
| Net sales | $16.460 | $18.341 |
| Gross profit / gross margin | $3.584 / 21.8% | $4.683 / 25.5% |
| Operating income / operating margin | $1.029 / 6.3% | $2.347 / 12.8% |
| Net income / net margin | $0.697 / 4.2% | $1.528 / 8.3% |
| Diluted earnings per share | $0.10 | $0.22 |
| Cash from operating activities | $0.288 | $(1.389) |
| Capital expenditures | $0.233 | $0.420 |
- Operating cash flow less capital expenditures was approximately $0.055 million. Cash declined $0.059 million during the quarter to $14.419 million.
- At September 30, current assets were $33.341 million and current liabilities were $4.714 million; the current ratio was approximately 7.1. Working capital was $28.627 million.
- No consolidated debt was outstanding. NAI reported $5.5 million available under its credit facilities and compliance with its credit agreement covenants. Management said available cash and expected operating cash flows should meet working-capital and capital-expenditure needs for at least 12 months.
- Two customers represented 72% of private-label contract-manufacturing sales (52% and 20%), down from 77% a year earlier. The filing identifies the customers in its discussion of sales trends as NSA International and Mannatech; the table labels them by customer number.
Material changes versus the prior year
- Sales fell 10.3%. Private-label contract manufacturing declined 11.2% to $14.744 million, mainly from lower volumes of existing products to existing customers. Lower sales to Mannatech and NSA were partly offset by new-product and other-customer sales.
- Patent and trademark licensing revenue increased 3.0% to $1.374 million, including a $0.354 million Abbott license fee and $0.103 million of beta-alanine raw-material sales. Branded-product sales declined 14.7% to $0.342 million, reflecting continued softening in Pathway to Healing.
- Gross margin contracted 3.7 percentage points. Management attributed the decline mainly to contract-manufacturing sales mix, higher material costs, and increased labor and overhead costs. Operating income fell 56.2%; SG&A rose 9.4%, including higher patent litigation and prosecution spending.
- Net income declined 54.4%. Other income turned to a small expense, chiefly reflecting unfavorable euro-related foreign-exchange activity. The effective tax rate for the quarter was 31.5%.
- Operating cash flow improved from use of $1.389 million to generation of $0.288 million. Accounts receivable provided cash, while inventory and accounts payable/accrued liabilities used cash. Days sales outstanding increased to 45 days from 25 days.
Outlook, commentary, risks and unusual items
- Management plans to pursue additional contract-manufacturing customers, expand commercialization of its beta-alanine patents, grow Pathway to Healing, and improve operating efficiency. It expected customer concentration to decline marginally during the rest of fiscal 2013 as new and existing customer sales develop; no numerical earnings or revenue guidance was provided.
- NAI reported $0.897 million of patent litigation and compliance expenses in the quarter, compared with $0.419 million a year earlier. Litigation involving DNP and Woodbolt/Cellucor includes challenges to the validity or infringement of NAI patents. The USPTO accepted requests to reexamine two patents; adverse findings could materially harm the business.
- Abbott may terminate the beta-alanine license and supply agreement. An October 2012 amendment, after quarter-end, provides for additional license payments on specified dates or milestone achievement and approximately $2.8 million in four annual payments beginning March 2014, subject to termination and other conditions. NAI cautioned that it may not receive these fees or future royalties.
- Customer concentration and reliance on a limited number of raw-material suppliers are material risks. Management also cited the availability of beta-alanine, demand, foreign-exchange movements, and protection of patent rights as factors affecting licensing revenue.
- NAI repurchased 27,433 shares for $0.151 million during the quarter. It recorded an after-tax unrealized derivative loss of $0.244 million in other comprehensive income; forward contracts had a net fair-value asset of $0.430 million at quarter-end.
Important facts for investors to verify
- Whether the sales decline and reduced contract-manufacturing margins persist, particularly for the two largest customers.
- Whether new-customer wins and product launches meaningfully reduce customer concentration and offset lower established-product volumes.
- Abbott’s decision and milestone outcomes, the timing and collectability of the amended agreement’s fees, and any resulting royalty or supply revenue.
- The status and potential financial impact of patent litigation and USPTO reexaminations, including continued legal spending.
- Whether the higher days sales outstanding, inventory needs, and supplier concentration affect cash conversion or production.
- Whether NAI continues to meet credit-facility covenants and maintains sufficient liquidity as its facility approaches its November 2013 expiration.